If your home's value has soared, congratulations. If you decide to sell, beware.
Financial advisor James Guarino says some clients don't realize that home-sale profits are potentially taxable until their returns are prepared — and by that time, they may have spent the windfall or invested the money in another house.
"They're not happy campers when they find out that Uncle Sam not only is going to tax this as a capital gain, but they're also going to have some exposure at the state level," says Guarino, a certified financial planner in Woburn, Mass.
Longtime homeowners who took advantage of previous tax rules, which allowed people to roll the gains from one home into the next, could be in for a particularly nasty surprise. Those old rules could trigger taxes even if you're under the current $250,000-per-person exemption limits.
Understanding how home sale profits are calculated — and how you can legally reduce your tax bill — could save you money and stress if you're planning to cash in on the current home price boom.
How tax rules have changed
Until 1997, home sellers didn't have to pay taxes on their profits if they bought another home of equal or greater value within two years. In addition, people 55 and older could use a one-time exclusion to avoid paying taxes on up to $125,000 of home-sale profits.
The Taxpayer Relief Act of 1997 changed the rules so that instead of rolling profits into another home, homeowners could exclude up to $250,000 of home-sale profits from their income. To qualify for the full exclusion, home sellers must have owned and lived in the home at least two of the five years prior to the sale. Married couples could shelter up to $500,000.